I am supposed to be working on a post about INCOME token, but this came up while I was doing my hedge fund work. Finally after some thinking about things, and talking to robots, I have my head around this "Impermanent Loss" concept.
What had me tricked out was the fact that I was sure I was making money through Impermanent Loss. I know, it's weird because it has the word loss right there in the name. Welcome to my weird world. But today I want to prove it with some math.
So we all know that HIVE pumps do some screwy things on hive derivative markets like hive-engine. At least, my readers do.
But seeing BXT back down to ~2 HIVE price so quickly has me thinking. Is this an overreaction? Its paying 38% apr on its LP... how risky can this be?
But wait, if we buy BXT, match it with Swap.HIVE in the LP, and BXT price goes up, won't we be losing money through Impermanent Loss? Nope - and I will show you today my secret to impermanent gains.
x*y=k
A little bit of knowledge can be even more dangerous than knowing nothing at all, and for me this idea has has me scratching my head for so long, and kudos to @edicted for some of his rants that have helped open my mind on the subject to a wide enough view to realize and conceptualize and work on verbalizing these ideas.
So lets do some easy math. We manage to buy some BXT at 2 swap.hive per, and match it in the pool.
100 BXT * 200 Swap.HIVE = 20'000 constant product (k)
We can then work backward and forward with arbitrary guesses, making a table like the below. Dividing the X/Y value them gives us relative prices:
| BXT | Swap.HIVE | K | Price (BXT in HIVE terms) |
|---|---|---|---|
| 120 | 166.667 | 20k | 1.388 |
| 100 | 200 | 20k | 2 |
| 90 | 222.222 | 20k | 2.469 |
| 80 | 250 | 20k | 3.125 |
| 75 | 266.667 | 20k | 3.555 |
| 50 | 400 | 20k | 8 |
So at this point I hope you can see how these things relate to each other. As the relative price varies, the amount of each will change.
From a price of 2, it would not surprise me if BXT could go back to 3.125. If this were to happen, according to the chart, we would have 80 BXT and 250 Swap.HIVE in the pool, worth 500 HIVE.
If you had held on to your 100 BXT and 200 Swap.HIVE, your theoretically HIVE worth would be 512.5 HIVE. The 12.5 HIVE difference is 'Impermanent Loss'. But as we can see, we have lost nothing, we are up 100 HIVE.
12.5 HIVE represents just over 3% of our original 400 HIVE investment. We have to consider yield as well, because supposedly we lost 12.5 HIVE for being in the pool over being out of it, but while in the pool we were earning 38% apr plus fees. This yield can more than offset Impermanent Loss figures, if this move took place over 40 days or more, we can be pretty sure we earned more in yield than we lost in theory over holding.
Extreme Revaluations
Impermanent Loss numbers get bigger as the ratios get out of whack, lets do the example of a 4x gain, eg BXT to 8 hive price.
Instead of having 100 BXT (now 800 HIVE) + 200 HIVE for a total of 1000 HIVE, we would have 50 BXT (now 400 HIVE) plus 400 HIVE for a total of 800 HIVE. So 4x yields a 20% impermanent loss. Our LP position doubles in value and if we have been in the pool for at least 6 months, a 38% yield will more than cover this concept of loss.
But the point remains, we now have 800 HIVE, which is not as much as 1000, but it is still much more than the 400 HIVE we originally invested!
What are you stacking?
I take profits in HIVE, not USD, and for this I can often find myself moving against the current of other investors. That is just fine with me. But with the concept of LP, it doesn't matter which type of value you are stacking, fear of Impermanent Loss is mostly irrational as long as you wisely choose your pairings.
The real risk of loss is that one token goes to zero, and this happens to be the SAME risk whether you are in an LP or not. Trading shitcoins is a sure path to destruction and its not the fault of constant product math. I hope this post can help you see where the real dangers lie.
Size matters
There is one other point to mention, and its about size. In a small pond it is easy to be a big fish. When dealing with large numbers, price impact starts to come into effect.
By dividing up an investments exposure to an asset, there is a reduced risk of being 'too deep' to get out. By investing 400 HIVE into BXT as 100BXT:200HIVE, we are hedging in some interesting ways. There are many benefits to being in an LP besides just yield, and also something to think about if you do not monitor the prices daily.
Always be very careful with your selection of tokens to trade with, and the longer you plan to hold, and the less you plan to check on them the more careful you should be.